(5) Allowance for Loan Losses

Management has an established methodology to determine the adequacy of the allowance for loan losses that assesses the risks and losses inherent in the loan portfolio. For purposes of determining the allowance for loan losses, the Company has segmented certain loans in the portfolio by product type. Historical loss percentages for each risk category are calculated and used as the basis for calculating loan loss allowance allocations. These historical loss percentages are calculated over a two-year period for all portfolio segments. Certain economic factors are also considered for trends which management uses to establish the directionality of changes to the unallocated portion of the reserve. The following economic factors are analyzed:

•

Changes in lending policies and procedures

•

Changes in experience and depth of lending and management staff

•

Changes in quality of Citizens’ credit review system

•

Changes in nature and volume of the loan portfolio

•

Changes in past due, classified and nonaccrual loans and TDRs

•

Changes in economic and business conditions

•

Changes in competition or legal and regulatory requirements

•

Changes in concentrations within the loan portfolio

•

Changes in the underlying collateral for collateral dependent loans

The total allowance reflects management’s estimate of loan losses inherent in the loan portfolio at the balance sheet date. The Company considers the allowance for loan losses of $15,445 adequate to cover loan losses inherent in the loan portfolio, at September 30, 2014. The following tables present, by portfolio segment, the changes in the allowance for loan losses and the loan balances outstanding for the nine months ended September 30, 2014 and 2013.


	Commercial & Agriculture			Commercial Real Estate			Residential Real Estate			Real Estate Construction		Consumer and Other			Unallocated		Total

For the nine months ended September 30, 2014

Allowance for loan losses:

Beginning balance	$	2,841		$	7,559		$	5,224		$	184	$	214		$	506	$	16,528
Charge-offs		(326	)		(1,720	)		(1,329	)		—		(65	)		—		(3,440	)
Recoveries		238			350			216			5		48			—		857
Provision		(1,148	)		1,655			201			176		18			598		1,500

Ending Balance	$	1,605		$	7,844		$	4,312		$	365	$	215		$	1,104	$	15,445

For the nine months ended September 30, 2014, the allowance for Commercial & Agriculture loans was reduced not only by charge-offs, but also due to a decrease in both the loan balances outstanding and the specific reserve required for this type, which was driven by a decrease in the volume of impaired loans. The net result of these changes was represented as a decrease in the provision. The increase in the allowance for Commercial Real Estate loans was the result of large charge offs, which led to increased general reserves due to an increase in loss rate. The net result of these changes was represented as an increase in the provision. The allowance for Residential Real Estate loans decreased during the period due to charge-offs of loans that had a specific reserve previously applied and a significant decline in past-dues and nonaccrual loans. The net result of these changes was represented as a decrease in the allowance. The allowance for Consumer and Other loans increased slightly from the beginning of the year. While loan balances and past-dues are up, loss rates continue to decrease resulting in the allowance being relatively unchanged. Overall, we have seen continued improvement in asset quality and loss rates. However, since the process of estimating probable credit losses requires considerable judgment, management decided to increase unallocated reserves. Unallocated reserves remain within policy guidelines as a percent of total reserves at 7.1 percent.


	Commercial & Agriculture			Commercial Real Estate			Residential Real Estate			Real Estate Construction			Consumer and Other			Unallocated		Total

For the nine months ended September 30, 2013

Allowance for loan losses:

Beginning balance	$	2,811		$	10,139		$	5,780		$	349		$	246		$	417	$	19,742
Charge-offs		(301	)		(1,266	)		(2,579	)		(136	)		(183	)		—		(4,465	)
Recoveries		123			257			364			107			69			—		920
Provision		418			(1,221	)		1,312			(160	)		27			724		1,100

Ending Balance	$	3,051		$	7,909		$	4,877		$	160		$	159		$	1,141	$	17,297

For the nine months ended September 30, 2013, the allowance for Commercial Real Estate loans was reduced not only by charge-offs, but also due to a decrease in both the loan balances outstanding and the specific reserve required for this type. The net result of these changes was represented as a decrease in the provision. The allowance for Real Estate Construction loans was reduced as a result of changes to specific reserves required and the historical charge-offs for this type. The result of these changes was represented as a decrease in the provision. The ending reserve balance for Residential Real Estate loans declined from the end of the previous year due to charge-offs during the period. Since these charged-off loans already had specific reserves assigned to them, we no longer need to carry as large a reserve for this segment. While we have seen improvement in asset quality, given the uncertainty in the economy, management determined that it was appropriate to maintain unallocated reserves at a higher level at this time.


	Commercial & Agriculture			Commercial Real Estate			Residential Real Estate			Real Estate Construction		Consumer and Other			Unallocated		Total

For the three months ended September 30, 2014

Allowance for loan losses:

Beginning balance	$	2,067		$	7,988		$	4,439		$	287	$	196		$	418	$	15,395
Charge-offs		(13	)		(146	)		(275	)		—		(22	)		—		(456	)
Recoveries		143			251			95			2		15			—		506
Provision		(592	)		(249	)		53			76		26			686		—

Ending Balance	$	1,605		$	7,844		$	4,312		$	365	$	215		$	1,104	$	15,445

For the three months ended September 30, 2014, the allowance for Commercial and Agriculture loans was reduced not only by charge-offs, but also due to a decrease in the loan balances outstanding, the balance of impaired loans in this segment and decreases in both the specific and general reserves required for this type. The allowance for Commercial Real Estate loans was reduced not only by charge-offs, but also due to a decrease in both the specific and general reserves required for this type. The result of these changes for each loan type was represented as a decrease in the provision. The allowance for Residential Real Estate loans was reduced as a result of charge offs, a reduction in total loans past due and a reduction in nonaccrual loans, partially offset by changes related to increased volume. The net result of these changes was represented as a decrease in the allowance. We have seen continued improvement in asset quality and loss rates. However, since the process of estimating probable credit losses requires considerable judgment, management decided to increase unallocated reserves. Unallocated reserves remain within policy guidelines as a percent of total reserves at 7.1 percent.


	Commercial & Agriculture			Commercial Real Estate			Residential Real Estate			Real Estate Construction			Consumer and Other			Unallocated		Total

For the three months ended September 30, 2013

Allowance for loan losses:

Beginning balance	$	3,775		$	9,156		$	5,169		$	184		$	149		$	972	$	19,405
Charge-offs		(210	)		(635	)		(1,558	)		(136	)		(61	)		—		(2,600	)
Recoveries		62			34			63			1			32			—		192
Provision		(576	)		(646	)		1,203			111			39			169		300

Ending Balance	$	3,051		$	7,909		$	4,877		$	160		$	159		$	1,141	$	17,297

For the three months ended September 30, 2013, the allowance for Commercial and Agriculture loans was reduced not only by charge-offs, but also due to a decrease in the loan balances outstanding and decreases in both the specific and general reserves required for this type. The allowance for Commercial Real Estate loans was reduced not only by charge-offs, but also due to a decrease in both the specific and general reserves required for this type. The result of these changes for each loan type was represented as a decrease in the provision. The ending reserve balance for Residential Real Estate loans declined due to charge-offs during the period. Since these charged-off loans already had specific reserves assigned to them, we no longer need to carry as large a reserve for this segment. While we have seen improvement in asset quality, given the uncertainty in the economy, management determined that it was appropriate to maintain unallocated reserves at a higher level at this time.


	Commercial & Agriculture		Commercial Real Estate		Residential Real Estate		Real Estate Construction		Consumer and Other		Unallocated		Total

September 30, 2014

Allowance for loan losses:

Ending balance:
Individually evaluated for impairment	$	655	$	67	$	896	$	—	$	—	$	—	$	1,618

Ending balance:
Collectively evaluated for impairment	$	950	$	7,777	$	3,416	$	365	$	215	$	1,104	$	13,827


Ending Balance	$	1,605	$	7,844	$	4,312	$	365	$	215	$	1,104	$	15,445


Loan balances outstanding:

Ending balance:
Individually evaluated for impairment	$	2,319	$	6,638	$	3,518	$	—	$	6			$	12,481

Ending balance:
Collectively evaluated for impairment	$	104,294	$	438,530	$	262,348	$	55,244	$	14,121			$	874,537


Ending Balance	$	106,613	$	445,168	$	265,866	$	55,244	$	14,127			$	887,018


	Commercial & Agriculture		Commercial Real Estate		Residential Real Estate		Real Estate Construction		Consumer and Other		Unallocated		Total

December 31, 2013

Allowance for loan losses:

Ending balance:
Individually evaluated for impairment	$	1,262	$	445	$	802	$	—	$	—	$	—	$	2,509

Ending balance:
Collectively evaluated for impairment	$	1,579	$	7,114	$	4,422	$	184	$	214	$	506	$	14,019


Ending Balance	$	2,841	$	7,559	$	5,224	$	184	$	214	$	506	$	16,528


Loan balances outstanding:

Ending balance:
Individually evaluated for impairment	$	3,869	$	10,175	$	4,005	$	—	$	8			$	18,057

Ending balance:
Collectively evaluated for impairment	$	112,006	$	433,671	$	246,686	$	39,964	$	10,857			$	843,184


Ending Balance	$	115,875	$	443,846	$	250,691	$	39,964	$	10,865			$	861,241

The following tables present credit exposures by internally assigned grades for the periods ended September 30, 2014 and December 31, 2013. The remaining loans in Residential Real Estate, Real Estate Construction and Consumer and Other loans that are not assigned a risk grade are presented in a separate table below. The risk rating analysis estimates the capability of the borrower to repay the contractual obligations of the loan agreements as scheduled or at all. The Company’s internal credit risk grading system is based on experiences with similarly graded loans.

The Company’s internally assigned grades are as follows:

•

Pass – loans which are protected by the current net worth and paying capacity of the obligor or by the value of the underlying collateral.

•

Special Mention – loans where a potential weakness or risk exists, which could cause a more serious problem if not corrected.

•

Substandard – loans that have a well-defined weakness based on objective evidence and are characterized by the distinct possibility that Citizens will sustain some loss if the deficiencies are not corrected.

•

Doubtful – loans classified as doubtful have all the weaknesses inherent in a substandard asset. In addition, these weaknesses make collection or liquidation in full highly questionable and improbable, based on existing circumstances.

•

Loss – loans classified as a loss are considered uncollectible, or of such value that continuance as an asset is not warranted.

Generally, Residential Real Estate, Real Estate Construction and Consumer and Other loans are not risk-graded, except when collateral is used for a business purpose.


	Commercial & Agriculture		Commercial Real Estate		Residential Real Estate		Real Estate Construction		Consumer and Other		Total

September 30, 2014
Pass	$	99,513	$	415,368	$	101,124	$	49,587	$	4,706	$	670,298
Special Mention		3,905		15,534		613		20		—		20,072
Substandard		3,195		14,266		8,897		43		73		26,474
Doubtful		—		—		715		—		—		715

Ending Balance	$	106,613	$	445,168	$	111,349	$	49,650	$	4,779	$	717,559


December 31, 2013
Pass	$	107,923	$	415,938	$	98,700	$	35,495	$	2,252	$	660,308
Special Mention		2,038		9,145		986		21		—		12,190
Substandard		5,914		18,763		8,175		—		70		32,922
Doubtful		—		—		2,349		—		—		2,349

Ending Balance	$	115,875	$	443,846	$	110,210	$	35,516	$	2,322	$	707,769

The following tables present performing and nonperforming loans based solely on payment activity for the periods ended September 30, 2014 and December 31, 2013 that have not been assigned an internal risk grade. The types of loans presented here are not assigned a risk grade unless there is evidence of a problem. Payment activity is reviewed by management on a monthly basis to evaluate performance. Loans are considered to be nonperforming when they become 90 days past due or if management thinks that we may not collect all of our principal and interest. Nonperforming loans may also include certain loans that have been modified in Troubled Debt Restructurings (TDRs) where economic concessions have been granted to borrowers who have experienced or are expected to experience financial difficulties. These concessions typically result from the Company’s loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions due to economic status. Certain TDRs are classified as nonperforming at the time of restructure and may only be returned to performing status after considering the borrower’s sustained repayment performance for a reasonable period, generally six months.


	Residential Real Estate		Real Estate Construction		Consumer and Other		Total

September 30, 2014
Performing	$	154,464	$	5,594	$	9,348	$	169,406
Nonperforming		53		—		—		53

Total	$	154,517	$	5,594	$	9,348	$	169,459


	Residential Real Estate		Real Estate Construction		Consumer and Other		Total

December 31, 2013
Performing	$	140,481	$	4,448	$	8,543	$	153,472
Nonperforming		—		—		—		—

Total	$	140,481	$	4,448	$	8,543	$	153,472

The following tables include an aging analysis of the recorded investment of past due loans outstanding as of September 30, 2014 and December 31, 2013.


September 30, 2014	30-59 Days Past Due		60-89 Days Past Due		90 Days or Greater		Total Past Due		Current		Total Loans		Past Due 90 Days and Accruing

Commercial & Agriculture	$	4	$	—	$	208	$	212	$	106,401	$	106,613	$	—
Commercial Real Estate		301		68		1,258		1,627		443,541		445,168		—
Residential Real Estate		810		768		4,164		5,742		260,124		265,866		—
Real Estate Construction		—		—		43		43		55,201		55,244		—
Consumer and Other		43		46		41		130		13,997		14,127		—

Total	$	1,158	$	882	$	5,714	$	7,754	$	879,264	$	887,018	$	—


December 31, 2013	30-59 Days Past Due		60-89 Days Past Due		90 Days or Greater		Total Past Due		Current		Total Loans		Past Due 90 Days and Accruing

Commercial & Agriculture	$	105	$	—	$	443	$	548	$	115,327	$	115,875	$	—
Commercial Real Estate		655		201		2,098		2,954		440,892		443,846		—
Residential Real Estate		3,140		1,084		5,531		9,755		240,936		250,691		—
Real Estate Construction		—		—		—		—		39,964		39,964		—
Consumer and Other		170		20		—		190		10,675		10,865		—

Total	$	4,070	$	1,305	$	8,072	$	13,447	$	847,794	$	861,241	$	—

Nonaccrual Loans: Loans are considered for nonaccrual status upon reaching 90 days delinquency, unless the loan is well secured and in the process of collection, although the Company may be receiving partial payments of interest and partial repayments of principal on such loans. Loans that are not delinquent 90 days or more may still be considered for nonaccrual status if management has recognized one or more weaknesses in a loan that indicate the Company may not be assured of collecting all principal and interest contractually due under terms of the loan. When a loan is placed on nonaccrual status, previously accrued but unpaid interest is deducted from interest income.

The following table presents loans on nonaccrual status as of September 30, 2014 and December 31, 2013.


	September 30, 2014		December 31, 2013

Commercial & Agriculture	$	1,148	$	1,590
Commercial Real Estate		5,993		9,609
Residential Real Estate		8,571		9,210
Real Estate Construction		43		—
Consumer and Other		75		50

Total	$	15,830	$	20,459

Modifications: A modification of a loan constitutes a troubled debt restructuring (“TDR”) when the Company for economic or legal reasons related to a borrower’s financial difficulties grants a concession to the borrower that it would not otherwise consider. The Company offers various types of concessions when modifying a loan, however, forgiveness of principal is rarely granted. Commercial Real Estate loans modified in a TDR often involve reducing the interest rate lower than the current market rate for new debt with similar risk. Real Estate loans modified in a TDR were primarily comprised of interest rate reductions where monthly payments were lowered to accommodate the borrowers’ financial needs.

Loans modified in a TDR are typically already on non-accrual status and partial charge-offs have in some cases already been taken against the outstanding loan balance. As a result, loans modified in a TDR may have the financial effect of increasing the specific allowance associated with the loan. An allowance for impaired loans that have been modified in a TDR are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or the estimated fair value of the collateral, less any selling costs, if the loan is collateral dependent. Management exercises significant judgment in developing these estimates.

Loan modifications that are considered TDRs completed during the nine-month periods ended September 30, 2014 and September 30, 2013 were as follows:


	For the Nine-Month Period Ended September 30, 2014						For the Nine-Month Period Ended September 30, 2013
	Number of Contracts		Pre- Modification Outstanding Recorded Investment		Post- Modification Outstanding Recorded Investment		Number of Contracts		Pre- Modification Outstanding Recorded Investment		Post- Modification Outstanding Recorded Investment

Commercial & Agriculture		—	$	—	$	—		—	$	—	$	—
Commercial Real Estate		—		—		—		2		547		547
Residential Real Estate		5		245		245		—		—		—
Real Estate Construction		—		—		—		—		—		—
Consumer and Other		—		—		—		—		—		—

Total Loan Modifications		5	$	245	$	245		2	$	547	$	547

Loan modifications that are considered TDRs completed during the quarter ended September 30, 2014 and September 30, 2013 were as follows:


	For the Three-Month Period Ended September 30, 2014						For the Three-Month Period Ended September 30, 2013
	Number of Contracts		Pre- Modification Outstanding Recorded Investment		Post- Modification Outstanding Recorded Investment		Number of Contracts		Pre- Modification Outstanding Recorded Investment		Post- Modification Outstanding Recorded Investment

Commercial & Agriculture		—	$	—	$	—		—	$	—	$	—
Commercial Real Estate		—		—		—		1		422		422
Residential Real Estate		3		97		97		—		—		—
Real Estate Construction		—		—		—		—		—		—
Consumer and Other		—		—		—		—		—		—

Total Loan Modifications		3	$	97	$	97		1	$	422	$	422

Recidivism, or the borrower defaulting on its obligation pursuant to a modified loan, results in the loan once again becoming a non-accrual loan. Recidivism occurs at a notably higher rate than defaults on new origination loans, so modified loans present a higher risk of loss than do new origination loans. At September 30, 2014, TDRs accounted for $1,618 of the allowance for loan losses.

During the nine-month period ended September 30, 2014, there were no defaults on loans which were modified and considered TDRs during the twelve months previous to the nine-month period ended September 30, 2014.

During the nine-month period ended September 30, 2013, there were two defaults, totaling $66, on loans which were modified and considered TDRs during the twelve months previous to the nine-month period ended September 30, 2013.

During the three-month period ended September 30, 2014, there were no defaults on loans which were modified and considered TDRs during the twelve months previous to the three-month period ended September 30, 2014.

During the three-month period ended September 30, 2013, there were no defaults on loans which were modified and considered TDRs during the twelve months previous to the three-month period ended September 30, 2013.

Impaired Loans: Larger Commercial loans and Commercial Real Estate loans or lending relationships at or above $350,000, many of which are 60 days or more past due, are tested for impairment. These loans are analyzed to determine if it is probable that all amounts will not be collected according to the contractual terms of the loan agreement. If management determines that the value of the impaired loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through an allowance estimate or a charge-off to the allowance. Additionally, if a Residential Real Estate loan or Consumer loan is part of a relationship with a Commercial loan or Commercial Real Estate loan that is impaired, then the Residential Real Estate loan or Consumer loan is considered impaired as well.

The following table includes the recorded investment and unpaid principal balances for impaired financing receivables with the associated allowance amount, if applicable, as of September 30, 2014 and December 31, 2013.


	September 30, 2014						December 31, 2013
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Recorded Investment		Unpaid Principal Balance		Related Allowance

With no related allowance recorded:
Commercial & Agriculture	$	1,379	$	1,504	$	—	$	1,525	$	1,657	$	—
Commercial Real Estate		5,632		6,191		—		5,983		6,214		—
Residential Real Estate		2,115		3,675		—		1,202		2,263		—
Real Estate Construction		—		—		—		—		—		—
Consumer and Other		6		6		—		8		8		—

Total		9,132		11,376		—		8,718		10,142		—


With an allowance recorded:
Commercial & Agriculture		940		1,056		655		2,344		2,437		1,262
Commercial Real Estate		1,006		1,123		67		4,192		4,496		445
Residential Real Estate		1,403		3,017		896		2,803		4,021		802
Real Estate Construction		—		—		—		—		—		—
Consumer and Other		—		—		—		—		—		—

Total		3,349		5,196		1,618		9,339		10,954		2,509


Total:
Commercial & Agriculture		2,319		2,560		655		3,869		4,094		1,262
Commercial Real Estate		6,638		7,314		67		10,175		10,710		445
Residential Real Estate		3,518		6,692		896		4,005		6,284		802
Real Estate Construction		—		—		—		—		—		—
Consumer and Other		6		6		—		8		8		—

Total	$	12,481	$	16,572	$	1,618	$	18,057	$	21,096	$	2,509

As of September 30, 2014, the Company has seen a significant decline in the unpaid principal balances for impaired financing receivables with a specific allowance as compared to December 31, 2013. The decline is the result of resolution of long term problem credits.

The following tables include the average recorded investment and interest income recognized for impaired financing receivables for the three and nine-month periods ended September 30, 2014 and 2013.


For the nine months ended:	September 30, 2014				September 30, 2013
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized

Commercial & Agriculture	$	3,570	$	104	$	4,984	$	156
Commercial Real Estate		9,227		239		12,328		438
Residential Real Estate		3,559		220		5,324		287
Real Estate Construction		—		—		377		—
Consumer and Other		7		—		35		—

Total	$	16,363	$	563	$	23,048	$	881


For the three months ended:	September 30, 2014				September 30, 2013
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized

Commercial & Agriculture	$	2,829	$	25	$	4,504	$	25
Commercial Real Estate		7,884		17		11,237		29
Residential Real Estate		3,336		74		4,773		18
Real Estate Construction		—		—		240		(11	)
Consumer and Other		6		—		21		—

Total	$	14,055	$	116	$	20,775	$	61